Risk Management Reports

May, 1997
Volume 24, No. 5

The Captain Speaking
One of the traditions of the sea is the captain's authority of command and full and absolute responsibility for whatever perils occur. Risk managers should periodically remind their CEOs of this tradition and its application to other organizations. Accepting responsibility is one of the requirements of leadership. Passing the buck is not permissible. Saying that "mistakes were made" is a cop-out. The proper response is "I made an error and I will correct it."

Roger Duncan's eloquent editorial in The Working Waterfront, for March 1997, reinforces this idea. Commenting on the effect of the plethora of marine safety laws and regulations,

Duncan observes that "in spite of all these beneficent laws and regulations, the government is not and cannot be responsible for the safety of crew and passengers. It is the skipper's responsibility and his alone. No government can legislate common sense, good judgment and a dash of luck. . . . (The skipper) cannot rely on that Providence which seems to watch over the ignorant, the careless and the intoxicated. No required equipment can substitute for the wisdom gained from experience."

This idea of accepting and acknowledging responsibility is, regrettably, absent in too many organizations today. It's an idea that risk managers should restore.

At the heart of our discontent lies an erosion of personal relationships. People no longer trust others as they once did; they no longer feel the same sense of commitment and obligation to others.

David Popenoe, "A World Without Fathers"
Wilson Quarterly, Spring, 1996

Auto Safety: Bags and Belts
Speaking of responsibility, I'm appalled at the recent rush of news articles complaining that air bags cause injuries. Air bags were originally designed to protect auto passengers from the effects of head-on collisions. With an auto death total in the United States exceeding 40,000 per year, the bags were widely hailed as a major step in improved safety. Unfortunately, engineers designed the bags to "explode" at 200 m.p.h. because research showed that most Americans would not use the earlier technology of the seat belt and shoulder harness. A higher-powered airbag was necessary to protect the largest adult not wearing other protection. The result: injuries to some and, in a few cases, death to smaller people and children. In addition, some parents inexplicably placed their children in rear-facing carriers in front seats despite prominent warnings to use them only in the back seat. Who then should be responsible for the resulting disaster: the parents, the air-bag manufacturers, or the infant carrier manufacturers? You guessed it - not the parents! We're now "redesigning" the air bag so that it is less likely to injure or kill small children. As we do so, we will reduce protection for adults!

Another absurdity is the law itself. Seat belt/shoulder harness use is mandated by law in most US states and Canadian provinces. You might expect that a lawsuit alleging injuries from an air bag without usage of other safety (required) equipment would be thrown out of court or at least subjected to the doctrine of contributory negligence. In Canada, the application of contributory negligence is relatively common, but, in the US, its use is infrequent. Some states, such as Kansas, Minnesota and Missouri actually prohibit its application for the non-use of seatbelts.

The law thus requires usage but prohibits the introduction of non-usage as a mitigating factor by a defendant.

As one observer, Brady Smith wrote recently in answer to an inquiry of mine on RiskWeb, "In one of those peculiar exercises of legislative 'logic,' some states mandate the use of restraint systems, enforce the law only in conjunction with a traffic stop for another reason (secondary enforcement), keep the ticket off the driving record, require that insurance companies offer a discount for having the restraint system in place, and then specify IN LAW that non-use of a required safety system for which the insured has received economic benefit CANNOT be considered contributory negligence."

Consider also the increasing use in autos of cellular telephones and the newly-introduced computer maps based on GPS (Global Positioning System). A study reported in the February 1997 issue of the New England Journal of Medicine suggests that talking on a cellular phone while driving is as risky as driving under the influence of alcohol - a quadrupling of the probability of an accident. The distracting use of a computer map may be even more serious. Where do common sense and personal responsibility begin?

What should risk managers do? First, develop an educational effort to encourage use of all safety equipment and to require that drivers pull over to use phones and maps. Second, enforce rigorous penalties when evidence proves that these requirements were not met. Third, begin an effort to bring some rationality to state laws for failure to use safety equipment properly or inappropriate use of phones and maps.

Let's look at the face of tragedy. Let's see its creases, its aquiline profile, its masculine jawbone. Let's hear its rhesus contralto with its diabolic rises: the aria of effect beats cause's wheezes.

Joseph Brodsky, "The Portrait of Tragedy"
The New Yorker, February 12, 1996

Political Risk
The wonderful world of the Web continues to delight and surprise me. Through it I found a new resource for regulatory and political risk management: Book 4 of Global Risk Assessments: Issues, Concepts and Applications.

Edited by Dr. Jerry Rogers, Professor of Management of Human Resources at California State Polytechnic University, in Pomona, CA, this is the fourth in a series of books, published in 1983, 986, 1988 and now, 1997. Dr. Rogers also heads a small consulting practice, Global Risk Assessments, Inc., in Riverside, California.

Book 4 features practical articles on political risk assessments, methodologies and case studies. Its three concluding chapters are more than worth the price of the volume ($42.50). "The Political Risk Analyst's Tool Kit: A Guide to Library Research," by Daniel Hanne, Business Librarian at Cal State Poly, summarizes global academic, institutional and governmental resources, ranging from the Asian Development Bank and the CIA, to the International Monetary Fund and the World Bank. Jerry Rogers adds two more sections, "Guide to Internet Research," and a current "Literature Review." The three make up a superb guide to sources for any risk manager.

Stephen Nairne, a Political Risk Analyst at the Export Development Bank in Ottawa, Canada, explores several new varieties of political risk. One is "creeping expropriation," defined as "unilateral changes in concession agreements; cancellation of import/export permits; embargoes or sanctions; unfair competition

from state-owned or local enterprises; lack of a legal system capable of impartially adjudicating disputes and enforcing binding contracts; delayed, unpredictable or discriminatory changes in the regulatory sphere; and jurisdictional complexities associated with the global trend toward decentralized administrative control." Another is "localized or subnational conflicts" and a third is the "imposition of temporary restrictions, limits or controls on the repatriation of foreign exchange." These risks are hardly confined to developing countries. Nairne also describes a working methodology for measuring these risks.

Roger Nye, a consultant with Global Investment Advisors, Inc., in Short Hills, New Jersey, argues that an over-emphasis on quantifying political risks, particularly from the well-known rating agencies, may distort our understanding. He believes that risk frameworks and procedures are "inherently subjective" because forecasting is a guessing game, indicators are indefinite, the quality of government management is almost impossible to quantify, national statistics used by rating agencies are notoriously soft, the analyst himself or herself is an independent variable, and the work of a "rating committee" inevitably reflects both perspective and "feel."

Book 4 includes two useful case studies, one on the sale of personal computers in Brazil and the second analyzing the Mexican devaluation in 1994.

Global Risk Assessments is available for $42.50 from Global Risk Assessments, Inc., 3638 University Avenue, Suite 215, Riverside, CA 92501 USA. Telephone and fax: 909-788-0672. Contact Jerry Rogers at jrogers@grai.com or his Web site: http://www.grai.com.

At the other end of the scale, the global market in small arms is breaking up the modern state's monopoly of the means of violence. The history of war has been about the state's confiscating violence from society and vesting it in a specialized warrior caste. But if the state loses control of war, as it has in so many of the world's red zones of insurgency and rebellion - if war becomes the preserve of private armies, gangsters, and paramilitaries - then the distinction between battle and barbarism may disappear.

Michael Ignatieff, "Unarmed Warriors"
The New Yorker, March 24, 1997

Cities at Risk
Last September, the International Decade for Natural Disaster Reduction (IDNDR), a United Nations initiative, sponsored an innovative two-month conference on the Internet (see RMR, September, 1996) to discuss how cities worldwide can act to reduce the effects of both natural and man-made disasters. The session drew 460 participants and 82,00 registered "hits" at the Conference site. It may be a model for future global discussion of major risk issues.

IDNR has published a "Cities at Risk" booklet, incorporating some of the discussion from the Conference. It should be on every risk manager's desk. Today's commerce is linked with the inter-connected services provided by our major cities. Yet these cities and their services are at greater risk today than ever before. As the Report argues, "More people are settling in areas vulnerable to hazards. Second, rapid population growth and migration make it difficult for authorities to protect people from disasters. Finally, urbanization is upsetting balances in ecosystems, with added disasters as a result."

Despite rising concerns and publicity about disasters, "The norm of most cities in developing nations is to cope with the immediate day-to-day challenge of biological and political survival," according to Spencer Havlick, a US disaster mitigation expert.

The major IDNDR concerns are earthquake, landslide, volcanic eruption, tsunami, tropical cyclone, flood, wildfire, drought and technological disaster. Loss of life and property damage are the results: the Tangshan (China) earthquake in 1976 killed 148,000; the Chittagong (Bangladesh) cyclone in 1991 killed 140,000; the 1994 Northridge quake in the US cost $30 billion, and the Kobe (Japan) quake in 1995 cost over $100 billion.

The potential for systemic disruption is increasing daily. The IDNDR prescription is risk management: encouraging urban authorities to lead the way in developing responses, to raise awareness among public, private and non-governmental organizations about the need to integrate planning, to develop new policies using successful example, and to facilitate networking globally.

Risk managers can play an important role by becoming active participants in this process in their communities. As risk management professionals they could lead. The IDNDR report suggests four action areas:

(1) Encourage development policies that reduce vulnerability to disasters (land use; risk assessment; disaster impact assessment; design, construction, maintenance; integration)

(2) Prepare city managers to cope with emergency situations (emergency management planning; institutional strengthening; communications channels and warnings)

(3) Prepare community members to address emergency situations (public awareness and education; community-based programs and solutions)

(4) Have special programs for high-risk situations (informal settlements; essential facilities; high-risk groups; cultural treasures; building with hazardous substances).

Natural and man-made disasters are part of our future. Even as we reduce loss of life and injury through early warning systems and improved construction, we concentrate new economic value in growing urban centers, increasing the potential for property loss.

IDNDR's message is that cooperation is essential. No organization, public or private, can go it alone. For the concluding years of this International Decade, IDNDR will focus on four primary themes, leading to a concluding global conference scheduled for mid-1999:

(1) Hazard, Risk and Vulnerability Assessment, including early warning and response capabilities.

(2) Disasters and Development, including review of economic and investment issues, insurance and risk management issues, and business continuity, protection and corporate interests. International commissions will try to obtain commitments on sustainable development, environmental protection, economic growth and social equity issues.

(3) Political and Public Policy Commitment, including national policy and decision-makers; municipal authorities; and community applications.

(4) Shared Knowledge and Technology, including information dissemination.

To accomplish these goals IDNDR has authorized the formation of a Leadership Coalition for Global Business Protection. Its mission: To pursue a compelling 'call to action' that will move public, private and community leaders individually and collectively to better (sic) prepare for and respond to natural and man-made disasters."

The national and international disaster management contact list, including email addresses, at the end of this report is alone worth the effort of obtaining a copy. Write IDNDR Secretariat, UN Department of Humanitarian Affairs, Palais des Nations, 1211 Geneva 10, Switzerland. Email: idndr@dha.unicc.org Telephone: +41-22-798-6894 Fax: +41-22-733-869

I understand for the first time the place of the city in the world, it should have been obvious but I never realized it, I had never been out of it before, never had the distance, it is a station on the amphibian journey, it is where we come out sliming, it is where we bask and feed and make our tracks and do our dances and leave our coprolitic spires,, before moving on into the black mountains of high winds and no rain.

E. L. Doctorow, Billy Bathgate
Random House, New York, 1989

Salaries and Risk
Is there a connection between payment of salaries and bonuses to employees and risk of loss to an organization? Should a risk manager be concerned with executive salaries? Recent events suggest that blatant disparities in executive remuneration or pay practices that reward inappropriate behavior can cause financial losses and well as damage to reputation.

If the absolute amount of remuneration stands out in contrast to other similar organizations, adverse publicity is almost certain to follow. Take the case of New York's Adelphi University. A compliant Board of Trustees rewarded its president with ever-increasing salary, bonuses and perks, to the tune of $837,000 in 1996, allegedly in return for his increasing Adelphi's endowment and his vision for a complete revamping of its curriculum. Yet the enormous salary, among the highest in the nation, a declining enrollment, an adversarial faculty, and allegations of conflicts of interest among the Trustees all led to the sacking of the entire Board and the president, with almost daily doses of adverse newspaper publicity earlier this year. The former trustees are even being sued for the recovery of "misspent" money. Adelphi is in complete disarray.

Look at how bonuses are structured. If the system is "heads I win, tails you lose," as appears to work in some investment houses, accepting excessive risk is rewarded excessively. As with Mr. Leeson at Barings and Mr. Citron at Orange County, when they are good, they are very good; when then are bad, they are awful. The problem is that each employee responds to risk differently: some are risk averse; some are dice throwers.

The compensation system should encourage the correct amount of risk taking, commensurate with the overall organizational risk management strategy. Penalties must match rewards to avoid over-extensions. UK's National Westminster Bank earlier this year reported a possible loss of L85 million ($136 million) from unauthorized options trades. It immediately withheld $12.8 million in staff bonuses, L200,000 ($320,000) from the offender's boss. Again reputation has been harmed, possibly because of a flawed compensation system.

Another example of wrong-footedness: Travelers Insurance Company rewarded its Chairman over $90 million in 1996 (a $1 million salary, $5 million bonus, and $85.2 million in stock options value) at a time when almost 1000 employees were laid off because of its merger with Aetna. Stockholders may have done well, but this enormous CEO compensation immediately attracted adverse press.

What role does a risk manager have in suggesting to senior management and the Board that large rewards following big layoffs can backfire? It's taking a chance but that's a risk manager's responsibility. The "risk" of adverse public reaction - from stakeholders and the community - is too great to overlook. Risk managers should alert their organizations to this risk and help consider what constitutes a "reasonable" reward.

I suggest the risk management function create a closer strategic tie with human resources so that critical questions can be raised about risk and reputation before ruinous rewards or compensation systems are offered.

Against human greed, no system is immune.

"Money and Politics"
The Economist, February 8, 1997

Alien Abduction
In the March 1997 issue of RMR, I suggested that millennial fever will bring many odd beliefs to the surface. The mass suicide of the Heaven's Gate cult is probably only the first of more examples of aberrational behavior in the next three years. That doesn't mean, however, that some able entrepreneurs won't try to take advantage of the situation. Bermuda's Royal Gazette reported on April 3 the past availability of insurance against "alien abduction, impregnation or attack." Originally offered by a UK brokerage firm, Goodfellow Rebecca Ingrams Pearson Ltd., the coverage has now been terminated because of Heaven's Gate, a policyholder. The group had purchased a $1 million policy for 50 members covering abduction, impregnation or death caused by aliens, for an annual premium of $1,000. It was one of some 3000+ policyholders buying this coverage.

According to Simon Burgess, the firm's managing director, it still offers insurance for all manner of off-beat risks: "We insure virgins against immaculate conception, prostitutes against loss of earnings from headache and backache, conversion to a werewolf or vampire, death or serious injury through paranormal activity, and unfaithful husbands against Bobbitting."

Now collecting on one of these insurance policies: there's the rub!

If the grief was deep enough, the world and everything in it was transformed into salvation of one kind or another. Hickum had always thought that a man broken badly enough in body and spirit could be sold anything at any price, and the more broken and troubled he was, the easier it was to sell him. Who else but poor, broken, and troubled men and women could be sending all that money to all those preachers on television who daily told all the poverty-ridden, death-stricken listeners who could hear their voices that the first thing they had to do was quit taking their medicine and quit eating so much food and quit trying to stay warm in the winter and send every cent they had to the Service of God? Then magically the address of the Service of God appeared on the screen.

Harry Crews, The Mulching of America
Scribner's, New York, 1995